Energy-Efficient Commercial Buildings Deduction (April 2006)

Beginning in 2006, there is a new deduction available for updating
or constructing commercial building property to be more energy
efficient. The Energy Tax Incentives Act of 2005 (ETIA), which took
four years to pass, added new Sec. 179D. With so many commercial
buildings exceeding 15 years in age, many business owners and
landlords may be considering significant updates to enable more
economical operation. Sec. 179D provides an immediate deduction for
the cost of energy-efficient improvements to commercial
property.

The maximum deduction allowed cannot exceed $1.80 per
square foot of the building, less the aggregate of all prior-year
deductions taken for the building under this provision. The property
basis is then reduced by the deduction taken. Although this new
deduction will primarily benefit real estate businesses, it will
have some benefit to owners of commercial lease property.

Example: Corporation, B, operates a 10,000
square-foot manufacturing facility located in the U.S. In 2006, as
part of a certified overall plan to reduce the total annual energy
and power costs, it spends $50,000. Under new Sec. 179D, B
can deduct $18,000 ($10,000 $1.80) immediately on its 2006
return. It will then capitalize the $32,000 remainder and
depreciate this over the asset’s useful life. In 2007, B
spent an additional $50,000 (which is also eligible for the Sec.
179D deduction). Because it already took the total deduction
allowed under Sec. 179D in a prior tax year, B has to
capitalize the entire amount spent in 20

Requirements

As with all new laws, there are specific
requirements that must be satisfied to enable taxpayers to claim the
new deduction. First, the building must be located in the U.S. and
be within the scope of Standard 90.1-2001 as in effect on April 2,
2003. Standard 90.1-2001 is a publication of the American Society of
Heating, Refrigerating, and Air Conditioning Engineers (www.ashrae.com) and the
Illuminating Society of North America. It provides minimum
requirements for the design of energy-efficient buildings. Further,
it has general industry acceptance and its language is often used in
new building codes.

Second, the property must be installed as
part of (1) the interior lighting systems, (2) the heating, cooling,
ventilation and hot water systems or (3) the building envelope. The
term “building envelope” is not defined in Sec. 179D; however, under
Sec. 25C(c)(2), the term is defined as including the wall and roof
assemblies, insulation, air/vapor retarders, windows and
weather-stripping and caulking. While Sec. 25C applies to
residential property, it may be reasonable to assume that a similar
definition would apply for Sec. 179D purposes.

Third, the
property must be certified as being installed as part of a plan
designed to reduce the total annual energy and power costs with
respect to the building’s interior lighting systems and heating,
cooling, ventilation and hot water systems by 50% or more in
comparison to a reference building that meets the minimum
requirements of Standard 90.1-2001. Note: to qualify for the
full deduction, the cost reduction plan must target all the systems
specifically identified in Sec. 179D(c) (1)(D). The reduction
applies to overall energy savings and not the savings of any
particular system.

The IRS is required to issue regulations
that establish a specific, energy-saving target for each system
(i.e., interior lighting, heating, cooling, ventilation and hot
water) and de-scribe in detail the methods for calculating and
verifying energy and power consumption and cost. The regulations
will be based on the provisions of the 2005 California
Nonresidential Alternative Calculation Method Ap-proval Manual.

Sec. 179D(d)(6) outlines the certification process. As part of
the regulations, the IRS is expected to provide guidance on how to
define qualified plan certifiers, to ensure compliance of buildings
with energy savings plans and targets. Such procedures will probably
be comparable to the requirements in the Mortgage Industry National
Ac-creditation Procedures for Home Energy Rating Systems.

Other Circumstances

Sec. 179D(d)(4) provides a special
allocation for improvements to public property. Because the
governmental owner is likely not a taxpayer, this section requires
the IRS to issue a regulation to allow an allocation of the
deduction to the person primarily responsible for designing the
property in lieu of the property owner. It is hoped that this tax
incentive will further encourage the development and innovation of
energy-efficient designs for use in municipal buildings.

Although a cost reduction plan should target a building’s overall
systems, Sec. 179D(d)(1) provides a partial allowance if a taxpayer
replaces one of the systems allowed under Sec. 179D(c) (1)(C), and
the replacement meets the target for that system. The partial
deduction available for the cost of the systems installed is up to
$0.60 per square foot of the building. These system-specific
improvements are also subjected to certification as designed by the
IRS. This may be an incentive to owners of commercial lease
properties, who pass on their utility costs to their tenants, to
consider installing energy-efficient systems.

In addition to
the above, Sec. 179D also directs the IRS to issue regulations as
necessary to take into account new technologies and to provide for
the recapture of the deduction if a plan is not fully
implemented.

No final regulations have yet to be issued on
these or any of the issues discussed herein.

Effective
Date

If taxpayers believe that a major energy savings
improvement to a commercial building will be necessary, new Sec.
179D may prove to be economical and thus worth considering. Further,
taxpayers in the business of designing energy-efficient government
property should be aware of allocated deductions that may be
available to them.

The Sec. 179D provisions, as currently
written, only apply to property placed in service after Dec. 31,
2005 and before 2008.

The winners of The Tax Adviser’s 2016 Best Article Award are Edward Schnee, CPA, Ph.D., and W. Eugene Seago, J.D., Ph.D., for their article, “Taxation of Worthless and Abandoned Partnership Interests.”

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